Forefront by TSMP: Sustainability Reporting: To What End?

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Forefront by TSMP

7 October 2019

Sustainability Reporting: To What End?

Activists and government leaders are sounding the death knell for our planet unless something is done about climate change. But while sustainability is important, sustainability reporting may not be the answer.

By June Ho

Cover photo credit: Ria Sopala / Pixabay

In a headline-hogging speech at the UN last month, 16-year-old environmental activist Greta Thunberg berated politicians and business people for doing too little to arrest climate change, ruining the globe for future generations.

High-profile scandals back up her claim. Last week, an organisation representing 470,000 German drivers started a closely watched, landmark lawsuit against the Volkswagen Group. The auto giant was implicated in an emissions-test cheating saga, admitting that it had installed “defeat devices” in millions of cars to pass stringent exams. To date, “Dieselgate” has already cost Volkswagen more than US$30 billion (S$41.6 billion) globally in penalties, compensation and costs.

In its 2014 sustainability report – published shortly before the fraud was exposed – the carmaker hammered home its “long tradition of resolute commitment to environmental protection”, repeating the word “environment” ad nauseam, 335 times over 156 pages. At that time, Volkswagen was a leader on the Dow Jones Sustainability Index (DJSI).

The cheat is allegedly the result of a concerted, company-wide (and possibly industry-wide) effort. Investors should then ask whether they can still trust sustainability reports which, by and large, are a collection of data self-curated with little regulatory oversight.

What is sustainability?

Sustainability refers to “ESG” –­­­ environmental, social and governance factors. The concept casts a wide definitional net, encompassing green building and environmental consciousness, community and charity work, and fair employment practices and management succession planning. Corporates are mandated to look beyond immediate profit-making and prioritise environmental considerations, social responsibility and corporate governance.

The case of the missing fish

Sustainability is, of course, important. Take Japan’s moribund herring industry. Until the 1950s, much of Hokkaido’s western coast was built upon this small silvery fish. As stocks slowly depleted, fishermen moved north. The last haul was less than a tenth of its peak and the following year there were no herring at all, never to return.

Thousands of jobs were lost in what was perhaps the first example of an entire industry collapsing due to overfishing. But probably not the last: in an uncanny 21st century re-enactment, catches of pacific saury had fallen by two-thirds in 2019. Japan’s answer? Start the regulated fishing season earlier next year.

It should not take a Swedish child activist getting to New York City in a boat, using a bucket as a toilet during the said crossing, to point out that the world must embrace sustainability, and not just as a “good-to-have”.

What is sustainability reporting?

Government regulators have taken heed. SGX-listed companies are now required to prepare annual sustainability reports, explaining how they have been fulfilling their ESG goals. Over 20 global bourses, including the London Stock Exchange (but not the New York Stock Exchange), have made such reporting mandatory. Sustainability reporting indexes have been established to provide frameworks to benchmark such reporting efforts, including the DJSI, the SGX Sustainability Index, the Global Reporting Initiative (GRI) and the International Integrated Reporting Council.

Sustainability reports are, in turn, relied upon by impact-conscious investors to determine if they should invest in such companies.

It is progress, at least in theory. But as currently practised today, sustainability reporting is not an effective and accurate way to assess investment targets.

The trouble with sustainability reporting

First, the ESG factors – which range from environmental impact (itself a very broad topic), CSR concerns, employment practices and business ethics, to management policies and succession planning – are too wide-ranging to make any comparison of potential investments meaningful.

Second, there is the long tail. Sustainability as an issue should be of importance to every living person, but whether a corporate adopts sustainable business practices may not have relevance to a short-term investor.

Next, the lack of standardised sustainability reporting guidelines and independent verification make these reports unreliable (as our Volkswagen spoiler revealed). Corporates have leeway to make self-promoting statements or, more likely, to cut and paste the reports of other companies just to comply with the reporting requirement.

Companies could, and often do, choose to puff up their strengths. Case in point, British Petroleum, which caused the worst oil spill in US history. Investigations into Deepwater Horizon uncovered cut corners, despite British Petroleum’s sustainability report claiming robust health and safety controls.

Finally, companies tend to over-report, inundating investors in reams of data and making it hard to pinpoint the most material risks. This is an issue made amusingly manifest by the fact that it affects even the people tasked to put the information together: for example, power group ABB overstated its sulphur emissions by a factor of 1,000 by mistaking kilotonnes for tonnes, three years in a row, before anyone noticed.

More nefariously though, in over-reporting, companies may also be simultaneously “under-reporting” by burying information on poor corporate behaviour, or worse, leaving it out completely. For instance, some fail to disclose data from individual countries or subsidiaries simply to make their sustainability reporting look better – which is tolerated in sustainability reporting, but will not meet financial reporting standards.

As such, we still have some way to go in producing objective reports that investors can rely on. In our current framework, sustainability reporting can be an expensive box-ticking exercise or a cynical public relations move, with companies picking the benchmark that best suits their interests.

The way forward

In order for sustainability reporting to make any sense, we need to do two things.

First, sustainability metrics need to be harmonised to a globalised standard.

We could advocate for a specific framework, with room for industry-specific adjustments. For instance, we could look at the World Federation of Exchanges (WFE), which has recently published a revised sustainability reporting guidance based on GRI for its member exchanges with the aim of standardising ESG reporting.

Second, sustainability issues should not be lumped together as one concept, as it only diffuses the impact of those factors on the investor’s decisions.

Governance is the common denominator for all companies. As such, of the three factors, it should be the cornerstone and needs more robust reporting and policing metrics.

From a purely financial investment perspective, environmental and social factors have a less immediate and direct impact on the investor, who may not attach as much significance to them. In addition, depending on the industry the company is operating in, the weightage to be assigned to such factors ought to differ.

For example, businesses such as mining companies and palm oil manufacturers, which are reliant on natural resources, tend to contribute more to pollution by their very nature. Companies with disruptive business models that are heavily reliant on a highly motivated workforce may need to institute better employment initiatives and community engagement programmes to attract and retain talent. Investors will be interested in how these corporates are handling environmental and social concerns respectively.

Moreover, if a company is in an industry where its sustainability efforts have a direct impact on investment, it will, as a good business practice, naturally publish an update on this, absent of a listing rule. So goes the question: why not let market forces decide?

Perhaps the issue here is too large for the free market to handle. Governments need to take the lead. In a promising move, in his 2019 National Day Rally Speech Prime Minister Lee Hsien Loong stressed the “grave” challenge of climate change and the extensive efforts the nation needs to put in as a whole in order to ensure its survival. Concerted – and sustained – government action will pave the way for corporates to seek excellence, not just in sustainability reporting, but in achieving ESG goals.